Cochrane, Inc., is considering a new three-year expansion project that requires
ID: 2630046 • Letter: C
Question
Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.49 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,280,000 in annual sales, with costs of $1,270,000. The project requires an initial investment in net working capital of $163,000, and the fixed asset will have a market value of $188,000 at the end of the project. Assume that the tax rate is 30 percent and the required return on the project is 8 percent.
What are the net cash flows for the following 3 years starting with 0?
What is the NPV of the project?
Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.49 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,280,000 in annual sales, with costs of $1,270,000. The project requires an initial investment in net working capital of $163,000, and the fixed asset will have a market value of $188,000 at the end of the project. Assume that the tax rate is 30 percent and the required return on the project is 8 percent.
What are the net cash flows for the following 3 years starting with 0?
What is the NPV of the project?
Explanation / Answer
Hi,
Please find the detailed answer as follows:
Part A:
Year 0 Cash Flow (Initial Investment) = -2490000 - 163000 = -2653000
Annual Cash Flow = (Sales - Cost - Depreciation)*(1-Tax Rate) + Depreciation = (2280000 - 1270000 - 2490000/3)*(1-.30) + 2490000/3 = 956000
Year 1 Cash Flow = 956000
Year 2 Cash Flow = 956000
Year 3 Cash Flow = Annual Cash Inflow + Recovery of Working Capital + Market Value*(1-Tax Rate) = 956000 + 163000 + 188000*(1-.30)= 1250600
Part B:
NPV = - 2653000 + 956000/(1+.08)^1 + 956000/(1+.08)^2 + 1250600/(1+.08)^3 = $44567.69 or $44568
Thanks